of money. In general, we have in the United States a continuous balancing and cancellation of debts and credits, first, in each locality; second, between each important city and its tributary territory, and, third, between the different important cities. Much the same process is characteristic of international exchange, but that is a topic which will be treated in another chapter.

Personal Credit. If a man does not hoard money on the one hand, or fail to pay his debts on the other hand, his expenditures (including investments) are bound to be, in the long run, approximately equal to his income. But for a business man a continuous equality of income and expenditure is impossible. At some times his deposit account will be built up more rapidly than he checks it out; at other times his need for means of making payments will outrun his receipts. If, for example, he is a contractor, whose expenses of production are fairly constant, but whose product is paid for only when completed, or a merchant, who replenishes his stock of goods twice a year but whose sales are distributed throughout the year, or a farmer who must pay his harvest expenses before he sells his crops, he may find it necessary to utilize his credit. This he does by giving to others rights to demand money from him in the future. Now, the extent to which he can utilize his personal credit, his power of purchasing things without immediate money payment, will depend to some extent on his personal ability and integrity. But, nevertheless, the fundamental measure of his credit will be the amount of his realizable wealth. This, however, may consist in part of property that is not "for sale," - his stock of consumption goods and his income-yielding land or capital, and in part of things that he hopes to sell in the normal course of business.

These things do not have to be sacrificed immediately in order to acquire the present means of payment. To meet a temporary need they may be made the basis of credit, through the process of hypothecation, a name which means the conditional transfer of property rights. The hypothecation may be definite and formal. as when a mortgage is given on specific items of property or when valuable credit instruments of various sorts (such as government or corporation bonds, bills of lading, warehouse

receipts, etc.) are put into the actual possession of the creditor as "collateral security"; or it may be simply implied, as in the case of an "unsecured" personal note, for practically all of the property of a borrower, over and above the items specifically hypothecated for certain debts is, in legal fact, hypothecated for his remaining debts. It is important to note, too, that future values, rather than present values, constitute the basis of present credit. The lender's interest is in the question of the adequacy of the money value of the security at the time when payment becomes due. Present prices being equal, a borrower can secure a larger amount of credit when market conditions are improving than when they are declining.

A man's probable future income and the probable future money value of his property, then, constitute the real measure and foundation of his personal credit. His personal credit, however, is of limited use to him as a means of payment. Some difficulties in the way of using personal notes as media of exchange have already been suggested.1 There is another difficulty in the fact that his personal notes will not be willingly accepted by others in lieu of money payments unless they know him, the value of his property, and the extent to which it is already hypothecated. Moreover, these same difficulties stand in the way of such notes being passed from hand to hand, even with successive indorsements.

Bank Credit. In order to acquire a readily available medium of exchange, personal credit has to be exchanged for bank credit.

1 It is true, of course, that business men often accept their customers' notes in payment of accounts, or as an equivalent for goods purchased. These notes, however, do not usually pass any farther as a medium of exchange, but are indorsed by the business man and presented to a bank for discount. Such notes, often known as "trade paper," constitute a large part of the securities of many commercial banks. In recent years, however, an increasing proportion of bank loans have been made upon "one-name paper." Buyers find it advantageous to secure the discounts for cash payments usually given by manufacturers, wholesalers, and jobbers, obtaining the necessary funds by borrowing from the banks on their own notes. The federal reserve banks are attempting to increase the use of paper bearing the names of both buyer and seller, and in particular to develop a larger use of bills of exchange (drafts) in place of promissory no. The purpose is to make it easier to distinguish those borrowings which arise from "actual commercial transactions."

Instead of using his own note as a medium of exchange, a business man will normally have it "discounted by his banker. If the note is for sixty days, for example, the business man yields the right to demand a specific amount of money from him in sixty days, in exchange for a deposit credit, - the right to receive on demand the same amount of money less the discount. The business man adds the note to his liabilities and the deposit to his assets. The bank adds the note to its assets and the deposit to its liabilities.

Having exchanged his personal credit for a bank deposit, the business man can now use the latter as a means of payment through the checking system that has been described. Ordinary commercial banking consists, in large part, of this purchase of personal credit and sale of banking credit. The bank builds up assets in the form of loans and discounts at the same time that it builds up its obligations in the form of deposits.

The security behind the deposit liabilities of any bank consists of: (1) loans and discounts, which in turn rest back upon personal credit or upon specifically hypothecated property (as in the case of loans on collateral security); (2) bonds, mortgages, and other securities owned by the bank, which, if necessary, may be sold for the benefit of the depositors, unless specifically pledged as security for bank note issues; (3) the bank's own deposits in other banks, together with the checks or similar claims against other banks that are in its possession; (4) its other property (building, fixtures, etc.); (5) (in national banks and some state banks) the personal liability of the bank's stockholders; (6) its stock of money.

1 Discount is simply one form of interest. Banker's discount differs from ordinary interest in that it is computed as a certain per cent of the total amount that is repaid, while ordinary interest is computed as a per cent of the amount that is lent. Discount is deducted from the principal of the loan in advance; interest is paid at the maturity of the loan or (on long time loans) at stated intervals. On demand or "call" loans and on time loans on collateral security "interest" rather than "discount" is charged.

* Even in case some of the bank's loans or securities prove worthless there is a margin of safety for the depositors in the fact that some of the assets of the bank represent the original investments of the bank's stockholders (“capital”) or profits which they have put back into the business ("surplus"), and on such assets the depositors have the first claim. Moreover, in national banks and some state banks

But that these assets should suffice to cover the deposit liabilities of a bank is not in itself sufficient to maintain its solvency. Much depends upon the character of the assets, the amount

of money included in them, and the ease and quickness with which other parts of the assets can be converted into money. Each deposit account is an obligation of the bank to pay in actual money if it is demanded. The depositor cannot use checks for all kinds of payments, but will often have to draw on his deposit account for money. Even when payments are made by checks, those who receive them will often prefer to cash them rather than to deposit them. Moreover, the process of the cancellation of credit obligations is, as we have seen, not altogether perfect. Balances arise between individual banks in the same city, between city and country, between different cities, and between different nations that very often have to be settled in money.

STATEMENT OF THE CONDITION OF A NATIONAL BANK IN A SMALL TOWN

A bank accordingly has to keep enough actual cash on hand to enable it to meet any demands that may be made upon it for money. As deposits constitute the most important cash obligations of most banks, the size of this money reserve, as it is called, is normally fixed for safety's sake at a certain per cent of the amount of the deposits. This proportion varies according to

the stockholders are in addition personally liable up to an amount equal to the par value of their holdings.

the location of a bank and the nature of its business. In practice it varies in different commercial banks from as low as 5 per cent to as high as 35 per cent of the deposits.

If its reserve increases, a bank is at liberty to increase its deposits by extending its loans and discounts, attracting these, possibly, by lowering the discount rate. If the reserve is decreasing, the bank must, for safety, contract its deposits by restricting its loans and discounts, or by taking measures (such as the sale of securities for money) that will replenish the reserve.1 In order that the ratio of reserve to deposits may be maintained near the point where the right balance is struck between profitableness on the one hand and safety on the other hand, it is necessary that the bank's assets should be as fluid as possible. This is best accomplished by confining most of the loans or discounts to notes or bills of exchange that are payable in thirty, sixty, or ninety days, or, at most, in four or six months, so that a constant flow of maturing obligations makes it possible for a bank to expand or contract its loans and discounts, and hence its deposits, as seems most advisable.

There has been in the larger cities of the United States, especially in New York, a growing use of bank loans payable on demand. This enables the banks to keep their outstanding loans much closer to the maximum allowed by the state of their reserves than would otherwise be the case, but the practice has, as we shall see presently, other effects that are not so desirable.

By the "money market" is usually meant the market for freely exchangeable rights to receive money on demand; that is, in reality, the bank credit market. The amount of bank credit available, the freedom with which banks will make loans on certain kinds of securities, and the interest and discount rates. charged for bank credit are among the things that make up what is called "the state of the money market." But it should be clear to the reader that the state of the money market depends,

1 Some banks maintain a "bond reserve" of high grade securities that may be sold to enable the bank to meet an extraordinary demand for money or to enable it to extend its loans and discounts when necessary. Such investments are normally made by commercial banks when the demand for loans does not absorb the funds at the bank's disposal, that is, when money reserves are unprofitably large.